I guess that the time will come when the Japanese will realise that their
government can only pay back their debt with worthless paper money, and like
the USA, the whole pack of cards will come tumbling down.

It has been a long time since Japan's bubble in stock and land prices
collapsed. Now, however, there is concern that a new kind of bubble -- a
"bond bubble" -- may be forming. Financial markets are already "saturated,"
according to analysts, with massive amounts of bonds that the government
issues each year. If such borrowing continues at the current rate of over 30
trillion yen a year, sooner or later it will create a huge glut of bonds,
possibly sending their prices into a tail spin.

The Finance Ministry seems well aware of the gravity of the situation. That
helps explain why it is trying hard to develop new outlets for government
bonds. Recently the ministry held briefing sessions abroad to lure foreign
institutional investors. Here at home, it has increased special bond sales
to individuals.

In the long run, the government has no choice but to reduce annual bond
issues. The basic requirement is to maintain a reasonable supply-demand
balance in the bond market. That makes it essential to pursue a prudent
bond-management policy. Failing that, the nightmare of a bond crash could
well become a reality.

Bond seminars for foreign institutional investors were held earlier this
month in London and New York. Officials from the Finance Ministry explained
economic developments in Japan, as well as the government's fiscal policy.
They also briefed about the simplified procedures, such as the unification
of forms, that will apply to tax-exempt measures for foreign bond purchasers
beginning this spring.

Foreign investors hold about 23 trillion yen in Japanese government bonds --
less than 4 percent of the total (including "zaito" bonds issued under the
fiscal investment and loan program, also known as the second government
budget). It is a pittance when compared with 40 percent for U.S. and German
government bonds.

The bond seminars were aimed at improving the international market
recognition of Japanese government bonds. Given their relatively low
international credit ratings, however, it remains to be seen whether foreign
investors will be willing to buy more. With the overall bond balance
exceeding the gross domestic product, Japan has the worst budget deficit of
the leading industrialized nations.

In yet another move to attract investors, the government last year began
selling price-indexed bonds. The selling point, of course, is that these
securities are shielded against losses from price changes.

Individual bond holdings in Japan make up only about 3 percent of the total
-- a figure that pales in comparison with those of America and Europe.
That's why the Finance Ministry started issuing "individual-only" bonds
several years ago. The balance now stands at about 8 trillion yen.

Unlike ordinary government bonds, these bonds carry no risks of price
fluctuation. Normally, national bonds vary in price and yield because they
are traded in the market. But the risk-free bonds can be transferred only
between individuals outside the market. As such, they can be regarded as a
new government-guaranteed savings vehicle that will likely replace current
fixed-amount postal saving accounts after the post-office network is
privatized.

There is the rub: If issues of individual-only bonds increase too much, they
may have a depressing effect on bank deposits. Banks buy bonds partly with
money deposited by individuals, so it can be said that depositors buy bonds
indirectly through banks. There must be limits to the sale of this
particular type of bonds.

The postal savings system, the largest purchaser of government bonds, holds
more than 90 trillion yen worth. Once the system goes private, however, it
will be unable to hold such an enormous sum of sovereign debt. So other
financial institutions will need to underwrite that portion of debt that
post offices have refused to buy, as well as additional debt issues. But
banks and insurers (including postal insurance) already hold huge amounts of
bonds: 77 trillion yen and 82 million yen, respectively.

In this way, postal privatization and bond management are intertwined.
Without a clear long-term outlook for bond sales it will be extremely
difficult to promote privatization plans. Yet neither Prime Minister
Junichiro Koizumi nor Economics Minister Heizo Takenaka (who is in charge of
postal privatization) appears willing to address the problem of bonds.

After all, finding new bond buyers, such as foreign investors and ordinary
individuals, is a halfway measure. In the final analysis, the best bond
policy lies in reducing new-bond issues. In fiscal 2005, the government
plans to issue 34 trillion yen of debt, slightly less than the year before.
Without a determined effort to reduce it over the long haul, however, the
level of borrowing will likely go up again in the future.

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